Companies that are capital intensive with low margins should stay away from bootstrapping. Here’s why.
Entrepreneurs have unlimited tenacity. They never give up. They never stop. They know the difference between running a hobby and a business. They believe in themselves and their company mission passionately. They know they’re going to succeed—if they could turn the corner, get that big order, attract investors or get a loan.
Entrepreneurs’ tenacity drives them to find a way to win, whether it’s not taking a salary, sacrificing friends or knocking down figurative (or actual) stone walls. Unfortunately, many entrepreneurs are doomed before they’ve begun because they try to bootstrap their business. Here are some reasons why bootstrapping can quickly kill your business:
1. Bootstrapping restricts growth.
Bootstrapping means starting your business with minimal cash and using your cash flow to fund growth. You can’t grow your business without money. Think about it: to build your business, you need cash to:
- buy more materials
- pay for marketing activities
- hire more salespeople
- increase your production capability
Some entrepreneurs try to use company profits to finance growth. The cash flow reality makes this a problematic strategy. Here’s how the process typically works:
- A sale triggers production.
- Then the product must be shipped.
- The invoice is sent out.
- The entrepreneur must wait between 30 and 90 days to get paid.
During that time, the entrepreneur loses access to the capital already invested and has no access, at all, to the profits. No cash means no growth. It may even result in collapse and failure. Entrepreneurs may soon find themselves starved for cash to make immediate payments such as payroll, rent, etc.
Especially in a growth cycle, bootstrapping is difficult. Let’s say the entrepreneur is experiencing 10% growth. The product recently shipped with 60-day payment terms. How does the company build 10% more product with less profitability, less cash, then it had 60 days earlier? The money is coming, but not until many tomorrows have passed. The entrepreneur never has enough cash to buy more machinery or make Friday’s payroll. Remember, too, that some receivables are never collected, reducing the amount of money that does arrive in 60 days.
The bottom line?
2. Bootstrapping is not a strategy for growth for most businesses.
If your business has high margins and you can produce and ship quickly, you may be the exception. Companies that are capital intensive with low margins should stay away from bootstrapping. It won’t work.
3. Use a cash flow pro forma to guide growth plans.
Completing a cash flow pro forma is like looking into a crystal ball of insight about your business. Ideally, you should prepare a pro forma before starting a company. This process will help you identify how long it will take you to break-even or make a small profit above the cost of goods, overhead and marketing expenses.
A cash flow pro forma is also like an airport runway. It will show you how much ‘run room’ you must have to become profitable. The time it takes to lift off is directly tied to your initial capitalization—the amount of cash you have available on Day One.
If you start out with $500 in cash, your business may not last long. Your money (your runway) ends out before you get off the ground. If your cash balance is $10,000, however, you can invest in marketing activities, hire a team and pay them, and invest in materials or the cost of goods. Your company can be up-and-running quickly.
If your pro forma analysis shows you don’t have the capitalization—the cash—to become profitable, then don’t move forward. Don’t start a business destined to fall off the runway or worse, fall off the cliff at the runway’s end. Either create a different company with a more favorable business plan or go out and raise the capital you need to fly.
4. Get capitalization for your business.
You have several options for raising capital. The path you choose should reflect your ambitions for your business. If you want growth, but not rapid-pace, then you won’t need massive amounts of cash and can be cautious about how much to pay for capital. If you’re determined to build big and build soon, then you’ll need lots of cash and need it fast. With this objective, you’ll pay more for capital.
You can obtain cash for your business can through two primary methods: investors (or equity financing) and borrowing (or debt financing).
- Equity financing means you sell a percentage of your business to investors.
Some entrepreneurs may not like the idea of sharing their business, but
the right investors can offer more than just cash. You can benefit from their
counsel, experience and connections to build your company. With equity
financing, you don’t have to make loan payments. It can, however, be a long
process to complete before you get the infusion of cash.
- Debt financing gives you faster cash and the responsibility of paying it back
with interest. You do have full control over how you use the money to help
your business, but small business loans can be challenging to get. Usually,
lenders look for significant collateral to guarantee a small business loan to
reduce their risk of losing money.
5. Plan for long-term success.
Having healthy cash flow keeps your business running and sets the stage for consistent growth.
Following this basic plan can help:
- Complete the cash flow pro forma
- Determine (and source) the right amount of cash to effectively launch your
- Reinvest some of the profits to finance growth
- Monitor cash flow on a regular basis (monthly) and adjust your operating
plan to keep cash flow strong
Remember, bootstrapping your business leads to quick failure. You can’t start with anything and expect to win. Smart capitalization is the better choice.
Talk with the team at Second Wind about your plan for business growth. We’ll discuss your capitalization options and help you identify ways to strengthen your cash flow.